China equity markets at an exciting juncture

It is hard not to notice the excitement the China equity markets have generated over the last few weeks, in terms of both returns and volume.

The China A-share market, which has nearly doubled in the last 12 months, recorded daily turnover of $290bn while the Hong Kong market rose over 30% since March 2014 and reached its own record of $37bn daily turnover not too long ago.

In our view, positive structural reform progress has played a large part in driving the strong returns, by reducing the left tail risks that have been associated with China and improving the sustainability and quality of growth.

However, the rally alone would not have multiplied trading volumes to the extent that we have seen. In terms of volumes, we think the key catalyst behind this was the CSRC’s announcement that domestic funds (even those without QDII quota) would be allowed to invest in the Hong Kong market via the MMA scheme.

Historically, capital account controls have meant that almost all of the funds in mainland China were limited to domestic investment options (aside from a very small QDII channel through previously defined QDII funds). But the opening up of market access could mean markets such as Hong Kong could see a larger influx of funds.

Further loosening of capital controls and opening up of the two markets’ access is just a matter of time.

The A-share and H-share markets remain largely separate with limited overlap in the pool of funds that drive these markets for now. The only access points are approved QFII/RQFII/QDII quotas and the MMA scheme.

These all have stringent limitations, such as eligible investors, the investible list of stocks, and the cross-border trading size allowed, to name a few. As China moves towards eventual capital account opening, we see continuous steps being made to remove these limitations.

For example, more retail and institutional investors will be able to use the MMA over time, QFII/RQFII/QDII quotas are likely to be meaningfully upsized, the Shenzhen Stock Connect to come later this year will probably increase the list of investible stocks on both sides as well as the daily and cumulative trading volumes allowed.

Eventually, once capital account opening is complete, the A-share market will be completely open to global investors while domestic investors will also have full freedom to ‘go out’. The two pools of capital will be merged. We believe the reforms to move towards this long-term objective will continue to positively surprise in terms of timing and impact.